Relative pricing and risk premia in equity volatility markets

Abstract: This paper provides empirical evidence that volatility markets are integrated through the time-varying term structure of variance risk premia. These risk premia predict the returns from selling volatility for different horizons, maturities, and products, including variance swaps, straddles, and VIX futures. In addition, the paper derives a closed-form relationship between the prices of variance swaps and VIX futures. While tightly linked, VIX futures exhibit deviations of varying significance from the no-arbitrage prices and bounds implied by the variance swap market. The paper examines these pricing errors and their relationship to VIX futures? return predictability.

Keywords: options; variance risk premium; variance swaps; term structure; return predictability; VIX futures;

JEL Classification: C58; G12; G13;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2018-09-01

Number: 867

Pages: 66 pages